Click to Enlarge The market heads into the year’s final few weeks looking like it’s setting up for a classic “Santa Claus rally.” The biggest potential driver of such a rally could very well be some swelling bearish sentiment, which could lead to a short squeeze flurry.
Wise traders eventually learn that the best time to sell stocks isn’t when everyone is screaming like the market is inches from the cliff, but instead when they’re acting like that cliff is just a crack in the highway. The former situation currently is in force, which means investors should be looking for technically strong stocks that the market is bearish toward — these are the stocks most likely to scale the “wall of worry” and result in a short squeeze higher.
There’s no better set of data to find candidates that match this profile than the most recent short interest data. As a reminder, short interest goes up on a stock as traders bet against it, so high short interest is a sign of a wall of worry. We target stocks that are in strong technical trends, as these are the ones that the shorts are often wrong on, sparking a powerful short squeeze here and there.
The accompanying table displays the most heavily shorted stocks among the S&P 500 that are trading in a technically strong pattern. That list is a great starting point for traders looking for a short squeeze candidate, but we want to take a closer look at three stocks:
Click to Enlarge Game retailer GameStop (GME) has been hit lately by what’s likely a “sell the news” situation — traders are stepping away from GME just as the holiday season releases are hitting the street, including new game consoles from both Microsoft (MSFT) and Sony (SNE).
The shorts were piling into GameStop stock ahead of the drop, meaning the shares were “pre-sold,” or discounted for this decline, and that there is a group of buyers (by way of having to cover their shorts) that will step in to help provide support.
This is one of the situations where the shorts might have been right (yes, they’re not always wrong), but the pending short squeeze still will help rally GME higher.
Biotech stocks have been hit of lately as this market-leading sector got a little too lofty for some traders. During the recent weakness, ILMN consolidated just above $90 and is now heading to break through $100.
The move above $100 likely will get the growing shorts to blink, sparking a short squeeze that should result in a breakaway above $100.
Like GameStop, the large number of short positions that have been added to Salesforce.com suggests the market already was pricing such a decline into the share price, meaning CRM shares are likely to see buyers enter the mix.
Conveniently, CRM is trading just above support from its 50-day moving average. Expect a short squeeze to move Salesforce.com back toward its highs and even shoot toward $60 before year’s end.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.